Those who run the IMF are supreme financial diplomats. They talk the opaque language of financial final communiques, the honed compromises between the great economic powers.
So when IMF managing director Dominique Strauss-Kahn acknowledged that the language of a recent IMF summit communique was “ineffective,” that the time for “real action” had come and that he feared “a race to the bottom” as the major countries began to outdo each other in beggar-my-neighbor currency wars, you should sit up and listen.
The problem is that we can talk and talk and talk, he said, but in the end something has to happen — and it has not. If countries chose not to co-operate in unravelling the problems facing the world economy, we all faced disaster.
Illustration: Mountain People
Washington blames Beijing for the impasse, saying it was manipulating its currency to export unemployment to the stagnation-stricken US. Beijing blames Washington for flooding the world with dollars and taking no responsibility as the hegemonic power for the fiscal and monetary discipline necessary to underpin the world’s key currency. Fears are growing that next month’s G20 meeting in South Korea will reveal the lack of cooperation.
It was the collapse of collaboration at the London summit in 1931 that launched the trade and currency policies that prolonged depression. Will history repeat itself?
The US is preparing to declare unilateral economic war on China by further swelling the flood of dollars when it adopts a US form of quantitative easing next month to boost anemic levels of bank lending. China will be swamped by yet more dollars displaced from the US, but is determined, as Bank of China Governor Zhou Xiaochuan (周小川) repeated, to move with extreme gradualism on its currency, if it moves at all.
Both, as in the early 1930s, imagine they can get better results by going it alone. And if they square up to each other, the rest of the world has no option but to protect itself, the dynamic that caused the competitive devaluations and trade protection of the 1930s.
This is the background to this week’s statement by British Chancellor of the Exchequer George Osborne, in which he will announce the fastest, deepest cuts in public spending ever mounted by any leading government in modern times.
Given the risks, the right policy would have been to embed flexibility in Britain’s spending, taxing and borrowing plans so the government could move fast to adjust to whatever happens. It is not what will be announced.
There was no need for such haste. Just as we took a decade to solve our problems after the crises of the mid-1970s and early 1990s, so we could have done the same today — aggressively cutting the deficit only when it became clear that there is an international bargain to better manage the world economy and when recovery is more assured.
After all, it has never been easier to sell government debt. Equally, if more of the burden of deficit reduction had been shouldered by planned tax increases, they could have been quickly deferred or abandoned to boost the economy if world economic prospects darkened. The haste to cut so blindly and so crudely, unless we are very lucky, will be seen by future historians as one of the great acts of economic folly.
Optimists insist China and the US will draw back from economic war and that the risks are manageable. The Chinese have let the yuan go up by 2 percent over the last two months, a concession noticed in Washington, and have pledged to lower their trade surplus. After all, with foreign exchange reserves of US$2.6 trillion, the highest of any country in history, the only way China can carry on acquiring reserves on this scale without risking massive inflation is through even more draconian controls on its banking and monetary system.
Change would seem rational. On Friday, US President Barack Obama deferred for another 90 days the launch of another weapon in the US’ economic arsenal — naming China as a currency manipulator and unilaterally imposing US tariffs on Chinese imports — in the hope that China was retreating. There could yet be a deal at the G20 summit.
But China’s economic model is constructed on sky-high savings and phenomenal export growth, especially to the US. Only last month, the US recorded its second-biggest monthly trade deficit; more than half was with China. Any bargain that makes sense requires China to spend more, save and export less, and the US to spend less and export more.
A US in the grip of the rising Tea party movement, with its fundamentalist, anti-state, go-it-alone, ultra-free-market philosophy, is hardly like to embark on the reforms required to make the US a more compatible trade and currency partner. It will do whatever it needs to protect US growth and jobs — and the rest of the world can adjust to it.
This, after all, is what the pre-Tea party US did to Japan in the late 1980s, forcing the yen to rise sharply, triggering a profound financial and banking crisis that delivered nearly two decades of economic stagnation. Now the Chinese fear that an even more aggressive US wants to do the same to them and that US quantitative easing is its chosen weapon.
The Chinese Communist Party could not survive two decades of Japanese-style stagnation, nor could it survive an upsurge in inflation. Its legitimacy is based on its capacity to deliver economically, not on bankrupt communist ideology. Nor can it easily boost Chinese consumer spending without establishing property rights and proper welfare with the accompanying rise in taxes, an existential threat to the regime.
In any case, we do not live in multilateral, international deal-making times. The Doha round of trade talks has been deadlocked for a decade. There is no agreement on climate change. Effective nuclear nonproliferation remains elusive. In the EU, member states take their cue from Euroskeptics jealously protecting national sovereignty. Unless something changes dramatically, it is hard to see how China and the US can do anything else but remain, at best, deadlocked, at worst, sliding towards economic war.
Britain, whose fortunes are entwined with the world economy, should be doing all in its power to avoid this disaster and to have a plan B to protect itself if disaster strikes. We should be offering to play our full part in any world deal to buy time for the US and China to change, while making sure we can act fast and flexibly to respond to a climate of beggar-my-neighbor trade and currency policies.
The spending review, and the budgetary judgment behind it, should have been framed to allow Britain to play its part in boosting world demand, help the world arrive at the compromises necessary to sustain economic order and make our recovery more secure. It will not be.
The coalition government has many admirable aims and that two political parties can work together so effectively is refreshing in a country used to single-party governments. But everything is being put at risk by once again kowtowing to the gods of financial orthodoxy. That was always wrong in the past. It is no less wrong today.
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